Thoughts on recent Ninth Circuit and California appellate cases from Professor Shaun Martin at the University of San Diego School of Law.

Monday, March 17, 2014

Purcell v. Schweitzer (Cal. Ct. App. - March 17, 2014)

This decision is correct. Though it unfortunately leaves unanswered what exactly we're supposed to do in situations like this one.

It's a pretty standard problem, and one with which attorneys are more than familiar. X owes Y some money; here, $85,000 on an unpaid promissory note. Y sues. The parties settle for $38,000. Installment payments.

So we have to deal with the obvious problem. After all, X didn't pay the installments due on the note. So what makes us think he actually pay the installments on the settlement?

We solve this problem the usual way we solve it: The parties stipulate to a judgment of the full amount due ($85,000) if any of the required installments aren't paid. That'll create the right incentives.

Garden variety. Done all the time. Generally works.

Now, in this case, there a wrinkle. One that makes X's position very, very sympathetic.

Under the settlement agreement, X's payments are due on the first of the month. They're considered late -- and a breach of the agreement -- on the fifth. Things go fine for a year or so. Installments paid on time. As expected.

But about a year and a half into the installment deal, in October 2011, for the first time, X is late. His installment payment is due no later than October 5. But he gets it in on October 11 instead.

Y cashes the check. But Y also immediately moves for and obtains a stipulated judgment for the amount due under the "full payment" provision.

Mind you, at this point, there's something like $700 of installment payments still due, at which point the settlement will be fully paid. But that doesn't stop Y from obtaining a stipulated judgment for over $58,000. Entirely on the ground that the October payment was six days late.

After X makes the final installment payments due in November and December, he moves to vacate the stipulated default judgment, asserting that it's an impermissible penalty. Of course, the parties had expressly said in the settlement agreement that it wasn't a penalty, and included various legalese to try to support this contention. But the trial court -- understandably -- wasn't buying it, and vacated the default judgment. The Court of Appeal agreed.

All of which is right. You can't jump on a guy being six days late in one of his payments to get a $50,000-plus windfall. I can't think of a better definition of an unjust penalty, and California law correctly refuses to enforce such a penalty. Even if the parties have "agreed" it's not one.

All well and good.

But what the Court of Appeal doesn't try to explain -- and it's definitely a tough question -- is where the line is between an impermissible penalty in situations such as this and a permissible one. What if the guy's not six days late, but sixty? What if the only reason he even makes that (late) payment is because you've already sought to enter the stipulated judgment? What if the guy's late not once, but seven times? Remember that these provisions are often included precisely in situations in which we've had prior experience with the guy not paying his valid monetary obligations. When can we finally say: Enough his enough?

At some point, you've got to be able to do that. Even though, yeah, truth be told, it is a penalty. Does the amount of the stipulated judgment truly "approximate" our costs in enforcing the judgment, blah blah blah, as the statute requires? No. That's not even the point. The point is instead to encourage the guy to make the payments due. To put precisely the type of financial pressure on him that the statute facially excludes.

I can see a decent argument that, in situations like this, it's not even really a "penalty". It's instead merely the removal of an "incentive". Remember: X totally owed $85,000, but the settlement agreement let him pay a fraction of this amount ($38,000) as full payment. But only if he actually paid, and did so on time. Once he defaulted (again) on his obligations, the incentive arguably legitimately disappeared. It's not that it would cost Y an additional $50,000 to hire a lawyer, etc. to go after the guy. We obviously can't prove that. But why should X be entitled to get the benefits of the agreement -- a large reduction in liability -- and yet still avoid his obligations thereunder?

That's a systemic problem in cases like this one. Because both under the Court of Appeal's reasoning as well as under the statute, it does seem like we may well be making it very difficult to enforce these types of settlement agreements. Because it's always (1) going to be hard to draw the line between late and "really" late payments (i.e., between material and immaterial breaches), and (2) even if we can satisfy (1), it's still almost always going to be an impermissible "penalty" since it'll be incredibly hard definitively establish the link between the amount that's due and what we now have to do to enforce the thing.

And that matters. Because if we can't be sure that we can enforce these provisions, then we won't be willing to settle. That's bad for the parties. That's bad for courts as well, who then have to continue to deal with the continued litigation.

It's not that I disagree with the result here. I definitely don't. This couldn't be a more obvious example of an impermissible penalty.

But the arguments and analysis in this case nonetheless raise the definitely important question of when these types of stipulated judgment agreements are in fact enforceable. Before reading this opinion, as a mediator and as an attorney, I'd have felt pretty confident about resolving disputes -- and keeping them resolved -- by including provisions like these. And have routinely employed them myself.

By contrast, after reading the opinion, I'm not at all sure they're enforceable. Certainly not easily, anyway.

So ponder this reality the next time you're faced with a similar situation. Sure, you can sign the relevant agreement. Whether you're on the debtor's side or on the creditor's.